Every year, the IRS releases its Dirty Dozen, which is a list of common scams taxpayers may encounter as they prepare their returns or hire people to help with their taxes. For the sixth time in the past seven years, “Improper claims of business credits”, “Excessive Claims for Business Credits,” or “Inflated Refund Claims,” were listed among the Dirty Dozen and below is what the IRS has to say about each topic:
Improper Claims of Business Credits: “Improper claims for the research and experimentation credit generally involve failures to participate in, or substantiate, qualified research activities and/or satisfy the requirements related to qualified research expenses. To claim a research credit, taxpayers must evaluate and appropriately document their research activities over a period of time to establish the amount of qualified research expenses paid for each qualified research activity. Taxpayers should carefully review reports or studies to ensure they accurately reflect the taxpayer’s activities.”
Excessive Claims for Business Credits: “Avoid improperly claiming the fuel tax credit, a tax benefit generally not available to most taxpayers. The credit is usually limited to off-highway business use, including use in farming. Taxpayers should also avoid misuse of the research credit. Improper claims often involve failures to participate in or substantiate qualified research activities or satisfy the requirements related to qualified research expenses. (IR-2019-42)”
Inflated Refund Claims: “Taxpayers should take note of anyone promising inflated tax refunds. Those preparers who ask clients to sign a blank return, promise a big refund before looking at taxpayer records or charge fees based on a percentage of the refund are probably up to no good. To find victims, fraudsters may use flyers, phony storefronts or word of mouth via community groups where trust is high. (IR-2019-33)”
The art of the R&D Credit lies in qualifying the activities. Rather than asking your provider what does qualify for the R&D Credit, consider asking them what doesn’t qualify. At the end of the study, your report should highlight what activities are included in your credit calculation, what activities aren’t included and what steps you can take to improve your documentation in subsequent years.
While having the documentation in place provides peace of mind that your credit will withstand an audit, paying a contingency fee for these services is not recommended by the IRS. According to Circular 230, “a practitioner may not charge a contingent fee for services rendered in connection with any matter before the Internal Revenue Service.” By charging a contingency fee, that provider is precluded from defending their work under audit in front of the IRS offering less protection for their client. Something else to consider is if a provider is charging a contingency fee based on credits identified, what is preventing that provider from including activities in the calculation that aren’t qualified so their fee can increase?
The R&D Credit can be one of the most lucrative tax benefits a company can receive, but the company must ensure it follows the proper substantiation procedures or it can find itself in a situation where it can lose the benefit and more. When searching for a trusted advisor to help your company increase ROI, bolster compliance and save you time, consider a provider that charges on a fixed-fee basis. By finding out how a provider is paid, that can determine whether they are able to defend the claim under Circular 230 or not.
The significance of the Dirty Dozen is it shows that the IRS has been paying attention to the R&D Credit for years and will likely continue paying attention in the years ahead. Knowing that documentation and audit defense are important for any R&D Credit claim, companies with eligible R&D activities should look for expertise in a team familiar with the territory and can guide them down the path creating peace of mind that what is reported is accurate and defensible.